In Part I I gave an overview of some of the “Get out of debt quick” schemes. Truly they are not schemes, but legitimate methods of getting out of or reducing debt. Unfortunately they also had negative consequences. The sooner you identify a problem with debt the better off you are. Starting off you are either fresh out of college, the military or high school. Everyone has a different situation be it debt from college loans, debt from the latest video game console release, or debt from being under paid in the military. Either way, reducing your debt in your twenties is a crucial step towards your financial future. Here I introduce a five-step course of action to get yourself out of debt.
Step 1: Admit That You Have a Problem
The initial step in resolving your debt should be acceptance. You have a problem and similar to Alcoholics Anonymous, the sooner you acknowledge this problem the sooner you can move on to resolving it. Dave Ramsey’s book “Total Money Makeover” goes through the problems of his readers in every chapter. In some cases, people were in debt for much as three to four times their annual income. It’s a scary situation. Fortunately, they realized that they had a problem and they addressed it. You can do the same. Talk to family or loved ones about your problem. Make it clear to them that you are looking for support, but not in a financial sense.
Step 2: Get Organized
Once you get a support system behind you, you can address the problem at hand. Now you should figure out how much you owe. Some people avoid this step because it’s daunting and depressing task, but as the saying goes, it’s “a necessary evil” that you are going to have to get over. Make sure you collect all of your statements and open them. Yes, that’s right… attack the pile of envelopes on your kitchen counter and open them all. Develop an easy filing system (I use accordion folders for mine), otherwise you will be wasting your time. The envelopes were sitting there idle for a reason – don’t give yourself an excuse to leave them lying around anymore!
Also, keep in mind that if you do not have a grip on your finances they will become out of control. It’s imperative to organize and review every invoice, every bill, and every statement. This is a dual purpose activity because it will also allow you to notice any errors that may appear on your accounts.
Step 3: Formulate a Plan
The first part of your plan should be to stop utilizing your credit. You’ll never pay it off if you keep using it. Not to mention that any time that you buy something, it will gobble up that last payment you made and you will be back to your old (high) balance.
After you’ve vowed to not use your credit cards anymore (You have, haven’t you?) you need to figure out how much per month you can afford to pay down your debt. And the “minimum payment” won’t cut it. It would be wise for you to budget more than just the monthly payment amounts, unless you plan on paying interest for years and never really get far. After this, you will need to determine your method of repayment. And I don’t mean cash or check.
There are two methods I will address: Bottom-Up Snowball and Top-Down Snowball.
Bottom-Up Snowball is what I call the “Dave Ramsey Snowball.” I call it “Bottom-Up” because it attacks the smallest debt first and goes upward from there. This creates a psychological sense of fulfillment and gratification as you quickly resolve debts. Here is how it works:
Tally up the debts that you have and record them in order from largest amount to smallest. Also document the minimum payment needed for that account.
Figure out how much you can afford to pay back each month towards debts (in total) and start subtracting the minimum payments for each account. Hopefully this is more than all of your minimum payments and you will have a chunk left.
Take what is left and commit it to the smallest debt every month, while making the minimum payments to each of the other accounts.
Take the following for example:
Debt: Balance: Min. Payment:
AMEX $5,000.00 $120.00
VISA $2,500.00 $20.00
Mastercard $500.00 $10.00
The total minimum payments amount to $150. We previously decided that we can afford to pay $500.00 per month. The “Bottom-Up” method will be to pay the minimum payments for the AMEX and VISA (higher balances) and be left with $360.00 per month to help pay off the Mastercard’s balance faster. Thus, each month, we will take the additional $360.00 and apply it to the $500.00 balance until it is paid off. A little quick math will reveal that within two months, we will have already paid off one account. But it doesn’t end there! For each account you pay off, you will roll the payment into the next lowest balance. So, out of the $500.00, you will contribute $380.00 of it to the VISA balance until that is paid off. And the payments go on until all the balances are paid off.
The Top-Down method is the one that most financial advisors recommend. With this method, you will attack the debt with the highest interest rate first. A similar approach applies to the Top-Down method, where will determine an amount that we can pay each month. Then we will figure out what interest rates are on each account. After you determine the minimum payments (like in the above chart), you will apply the $360.00 per month towards the account with the highest interest rate until it is paid off. Once an account is paid off, you move on to the next highest interest account.
The rationale behind this method is that it saves you money. A higher interest rate means you will be paying a higher price for the debt, whether it’s $500 or $5,000. If you decide to pay off the lower balance card first, you may find that your personal gratification is diminished when you see the high interest payments on your other cards because they had a higher interest rate. Personally, I’ve found that the human psyche is much more powerful – when I pay off a balance, I have added incentive to keep going, even though I know in the back of my head that my other cards are racking up interest… But pick what works best for you.
Take a breath! That was a lot to read, but look how much you’ve already done! You’ve already determined you have a problem spending money, You’ve committed to reducing your debt and saving. You’ve made a plan… Now its time to execute your plan.
Step 4: Follow Through
Talk to your friends, your family, perhaps even start a weblog! Whatever you need to do in order to follow through and put your plan to action you should. Make yourself accountable, because following through and staying committed is incredibly hard to do. I’ll even admit that lately I’ve been struggling with my goals because the child inside of me keeps flaring up yelling “I WANT THAT! I WANT THAT!” It takes a lot, but as a personal reflection, I know that I am far stronger today at the ripe age of twenty-four than I was just a few years ago or even before I got married. I am more committed to financial management and my goals than to purchasing the latest game console… No matter how bad I want it!
Step 5: Review
As with everything else in your world of personal finance, you should keep track of your debt. This will allow you to know where you stand financially, at anytime. Designate a day of the week, (like an hour on Thursday) to review your financial plans and objectives. Make sure that your debt management solution is working. If it’s not, you need to correct it. Yeah, I’ve heard “Well, a broken system is better than no system,” but that is not necessarily true because it can get you into a lot of trouble. Make sure that it is a functional system. Review also allows you to stay ahead and figure out your next move. Always keep in mind that life changes, so don’t hesitate to make adjustments as you need to!
I hope this article helps you in your journey towards being debt free. In my own endeavors and struggles, I have tailored the “Bottom-Up” approach from Dave Ramsey’s book “Total Money Makeover” to dig out of debt. It worked quite well for me, but learning how to fix debt problems is only half the battle. Actually applying the techniques and keeping with it is another. Best wishes.
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External Related Articles:
Three B.A.D Way’s to reduce debt
Reducing Debt With a Snow Ball
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Thanks for the link love. Great post, keep it up!